What has history shown us about investing?

As part of our 'Timeless Investing' series of articles, we will look at some of the key elements of investing and how your investment decisions today can affect your future. This article looks at what history has shown us about investing.

Climbing the risk/return ladder

The higher you climb on the risk/return ladder, the greater the risk taken to achieve a higher potential return. Term deposits are generally very safe but returns are unusually low. Shares involve more risk but the potential returns are higher. For more long-term investors, it’s not a case of choosing one or the other. To spread risk without sacrificing return, it’s usually smart to have a combination of investments.

Expected long term returns and risks

Source: AMP Capital, 2013. Returns provided are not forecasts and are intended purely to illustrate premiums. Premiums provided are based off an inflation rate of 2.5%.

Time is on your side

Over long periods of time, investing in shares will almost always provide a higher return than investing in term deposits. As you can see, investors who switched out of shares into cash seeking short-term reprise during the uncomfortable period of the Global Financial Crisis have not recovered the value of their investments. However, investors who remained fully invested in shares were better placed for longer term.

Switching out of shares to cash

Source: Bloomberg, Mercers, Iress, Data as of 31 December 2012.

Shares pass the test of time in Australia

The shape of this chart tells a story. On the left of the vertical line are the years that the Australian share market has fallen since1981, the first full year after the All Ordinaries index started. On the right are the years the market rose. Since 1981, markets have risen by approximately 20% or more in a year on 10 occasions and fallen by more than 20% just once. Over long periods, the good has definitely outweighed the bad.

Dividends deliver stable income

While term deposits have recently been offering attractive interest rates, we are now seeing a fall in the rates on offer. Currently, dividends delivered by Australian companies are attractive, and when we include the benefit of franking credits, this income stream is even more attractive. In addition to this, investing in shares provides an opportunity for capital growth. The key to sustaining this more stable income stream is to remain fully invested in shares.

The yield offered by term deposits is less than that of Australian shares

Long-term investors ride the ups and downs

Share markets have their ups and downs as the major events of our time have an impact on investor sentiment and the performance of listed companies. Recently, the Global Financial Crisis has had a major impact on the Australian share market. However, it’s important to keep in mind that the market has always recovered from major events and moved on to new highs.

Actual index level

Source: Bloomberg, ASX All Ordinaries Index, Data as of 31 December 2012.

Remembering the crash of 1987

While markets have not yet recovered to the levels they were at before the Global Financial Crisis, we can look at other share market falls and take a lesson from them. The below graph shows that while the 1987 share market crash had a major impact, with time it has become a ‘blip’ in the long-term upward trend in markets. The Australian share market has been through many ups and downs since, but by the end of 2012, it had risen significantly. Time heals.

Performance of Australian share market, 1987 - 1989

Source: Bloomberg, ASX All Ordinaries Index.

Conclusion

While the international share price index has more than doubled since 1987, the past decade has been a torrid time for overseas share markets with not one but two distinct bubbles followed by severe downturns. Unfortunately, timing these ups and downs reliably is impossible. No-one knows for sure when these markets will reach the bottom – however, history shows that having the courage to stay invested through the market’s ups and downs usually pays off.

Act now for a better tomorrow

To learn more about how to build your wealth and investing, speak to your financial adviser or explore our range of investment options.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs.